The Lebanese government would be broke if it were not for the country’s banks. For decades the banks have lent to the sovereign to help make up the vast difference between money it spends and money it takes in. Of late, however, bankers have been increasingly vocal that they are no longer happy to lend money to a government that has shown no sign that it will ever be able to to pay the money back.
“Banks can’t continue indefinitely financing the deficit and the high level of public expenditure without concrete reforms,” says Nassib Ghobril, chief economist at Byblos Bank. “Some banks have been very clear in that they are willing to renew maturing issues but not to subscribe to totally new issues.”
As of September 2011, Lebanon’s debt stood at $54.37 billion, according to the latest figures from the Ministry of Finance (MoF). Holding 50 percent Lebanon’s outstanding Treasury bills and 70 percent of its outstanding Eurobonds, the tab owed to local Lebanese banks amounted to $29.4 billion at the end of 2011, according to the Association of Banks in Lebanon.
Given that the government has, for the sixth year running, failed to pass a national budget, while also recently upping spending through, among other things, implementing a wage increase package for most public sector workers without any offsetting revenue gain, there is little hope for a short-term reduction in the deficit or debt. Quite the opposite actually: with more than $12 billion in debt maturing this year — $2.35 billion in Eurobonds and LL15 trillion ($10 billion) in treasury bills — the MoF has stated it aims to raise $5 billion in Eurobonds and T-bills to cover the 2012 public deficit and the maturing debt.
Tied to a stone
The exposure to the public debt is restricting the banks’ rating and constitutes a burden on their balance sheets,” says Ghobril. In short, lower credit ratings mean higher borrowing cost for the banks, but their credit ratings are effectively capped by those of the Lebanese government, given how much of the banks’ balance sheets are made up of Lebanese government debt.
Nadim Kabbara, head of research at FFA Private Bank, concurs: “Most of the debt is held locally by commercial banks and the central bank and as such both the government and banks are joined at the hip.” In Moody’s December report on Lebanese banks, in which it downgraded the outlook on the sector from stable to negative, it stated that Lebanese banks’ “credit risk profile will continue to be closely linked to that of the Lebanese government.”
With an estimated debt-to-gross domestic product ratio of 137 percent, Lebanon has one of the highest debt ratios in the world, which makes the banks’ exposure to this debt increasingly unsettling.
“We had several moments in our recent history where we could have put in place reforms; clearly for political reasons those reforms have stalled,” says Khaled Zeidan, general manager at MedSecurities, a BankMed subsidiary.
Biting at the yields
Zeidan added, however, that rather than refusing new debt issues altogether, “I expect banks will try to negotiate higher yields for the new bond issues with the Ministry of Finance.”
The average yield on a Eurobond in early March stood at 4.33 percent; yields on T-bills offered higher returns, with two-year T-bills returning 5.4 percent and five-year T-bills returning 6.2 percent. The International Monetary Fund recently published a report in which it argued for increased interest rates on T-bills that have a less than seven-year maturity, to compensate for the country’s higher risk and make them more attractive for local banks. Towards the end of last month yields began moving in that direction, with the yields on one-year, two-year and three-year T-bills increasing some 50 basis points in the weekly T-bill auction on March 22.
Incestuous debt
In many ways the local banks are locked into continuing to lend to the government: having lent so much already, they can ill afford to even contemplate a sovereign default and thus are, in a sense, forced to step in to cover the budget shortfall if no one else will.
An alternative to local banks would be for international investors to fill the gap, but that is easier said than done. In August of last year, at the height of the Arab revolutions and the European debt crisis, Lebanon issued a $1.2 billion Eurobond, which saw international investors come in for 21 percent of the subscription, raising questions on whether they would be willing to subscribe again this year.
“I don’t believe that foreign institutional investors today have sovereign Lebanese credit on their radar as yields on Lebanese debt are either similar or lower than other regional and emerging market sovereign issues,” says Zeidan. Marwan Abou Khalil, head of capital markets at BLOMINVEST Bank, expects that the international investor community would require the implementation of debt reforms as a main condition of any subscription.
Looking ahead
After several years of double-digit deposit growth, local banks still managed to realize an 8 percent in 2011. While some $118 billion in deposits will keep Lebanon’s banks afloat on abundant liquidity, the prospects for more growth this year are quite dim as neighboring Syria remains in turmoil and the global economy fragile. With slower deposit growth, interest spreads, the main source of banks’ income, need to widen to maintain the net income of banks. Raising their exposure to the sovereign debt without a risk-adjusted compensation will only squeeze banks’ balance sheets further, thus they are likely to demand better returns on money they lend the government. Higher yields would also provide banks with more leeway to increase rates on deposits.
From the government’s perspective, higher yields entail higher debt payments, meaning the government is spending more money it has not yet figured out a way to earn, thus it will be reluctant to up its own cost of borrowing.
Both sides have too much to lose to let the confrontation elevate to the level where the government is unable to pay its bills, but that does not mean there will not be some tense negotiations and brinkmanship, as the details of how it all plays out are of fundamental importance to everyone.
